DOCSLIB.ORG

Best Practices in Risk Management for Securitized Products

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Best Practices in Risk Management for Securitized Products ≈√ Guidelines on Credit Risk Management Best Practices in Risk Management for Securitized Products These guidelines were prepared by the Oesterreichische Nationalbank (OeNB) in cooperation with the Financial Market Authority (FMA) Published by: Oesterreichische Nationalbank (OeNB) Otto Wagner Platz 3, 1090 Vienna, Austria Austrian Financial Market Authority (FMA) Praterstrasse 23, 1020 Vienna, Austria Produced by: Oesterreichische Nationalbank Editor in chief: Gu‹nther Thonabauer, Secretariat of the Governing Board and Public Relations (OeNB) Barbara No‹sslinger, Staff Department for Executive Board Affairs and Public Relations (FMA) Editorial processing: Luise Breinlinger, Yi-Der Kuo, Alexander Tscherteu, Florian Weidenholzer (all OeNB) Thomas Hudetz, Werner Lanzrath (all FMA) Design: Peter Buchegger, Secretariat of the Governing Board and Public Relations (OeNB) Typesetting, printing, and production: OeNB Printing Office Published and produced at: Otto Wagner Platz 3, 1090 Vienna, Austria Inquiries: Oesterreichische Nationalbank Secretariat of the Governing Board and Public Relations Otto Wagner Platz 3, 1090 Vienna, Austria Postal address: PO Box 61, 1011 Vienna, Austria Phone: (+43-1) 40 420-6666 Fax: (+43-1) 404 20-6696 Orders: Oesterreichische Nationalbank Documentation Management and Communication Systems Otto Wagner Platz 3, 1090 Vienna, Austria Postal address: PO Box 61, 1011 Vienna, Austria Phone: (+43-1) 404 20-2345 Fax: (+43-1) 404 20-2398 Internet: http://www.oenb.at http://www.fma.gv.at Paper: Salzer Demeter, 100% woodpulp paper, bleached without chlorine, acid-free, without optical whiteners DVR 0031577 Vienna, 2004 Preface The ongoing development of contemporary risk management methods and the increased use of innovative financial products such as securitization and credit derivatives have brought about substantial changes in the business environment faced by credit institutions today. Especially in the field of lending, these changes and innovations are now forcing banks to adapt their in-house software systems and the relevant business processes to meet these new requirements. The Guidelines on Credit Risk Management are intended to assist practitioners in redesigning a banks systems and processes in the course of implementing the Basel II framework. Throughout 2004 and 2005, guidelines will appear on the subjects of securi- tization, rating and validation, credit approval processes and management, as well as credit risk mitigation techniques. The content of these guidelines is based on current international developments in the banking field and is meant to provide readers with best practices which banks would be well advised to implement regardless of the emergence of new regulatory capital requirements. The purpose of these publications is to develop mutual understanding between regulatory authorities and banks with regard to the upcoming changes in banking. In this context, the Oesterreichische Nationalbank (OeNB), Austrias central bank, and the Austrian Financial Market Authority (FMA) see themselves as partners to Austrias credit industry. It is our sincere hope that the Guidelines on Credit Risk Management pro- vide interesting reading as well as a basis for effective discussions of the current changes in Austrian banking. Vienna, December 2004 Univ.Doz. Mag.Dr. Josef Christl Dr. Kurt Pribil, Member of the Governing Board Dr. Heinrich Traumu‹ller of the Oesterreichische Nationalbank FMA Executive Board × 3 Contents 0 Introduction 7 1 Fundamentals 8 1.1 Motivation and Delineation 8 1.1.1 Motives behind Securitization 9 1.1.2 Delineation of Securitization Transactions 9 1.2 Common Structures 10 1.2.1 Ways of Assuming Risk 11 1.2.2 Basic Types of Securitization Transaction 12 1.3 Current Developments 16 1.3.1 New Securitization Structures 16 1.3.2 The Austrian Securitization Market 18 2 Risks 20 2.1 Essential Types of Risk 20 2.2 Credit Risks 21 2.2.1 Origins of Credit Risk 21 2.2.2 Limitation 22 2.2.3 Distribution 23 2.3 Structural Risks 24 2.3.1 Market Risks 24 2.3.2 Liquidity Risks 24 2.3.3 Operational Risks 26 2.4 Legal Risks 27 2.4.1 General Treatment 27 2.4.2 Enforceability of Claims 29 2.4.3 Availability of Information 31 2.5 Relevance of Risks to the Parties Involved 32 2.5.1 Incomplete Transfer of Risk from the Originator 32 2.5.2 General Risks Assumed by the Investor 33 3 Risk Measurement 33 3.1 Defining and Quantifying Risk 34 3.2 Approaches to Quantifying Credit Risk 35 3.2.1 Origin of Credit Risk 35 3.2.2 Limitation and Distribution 36 3.3 Quantification Approaches for Structural Risks 38 3.3.1 Market Risks 38 3.3.2 Liquidity Risks 38 3.3.3 Operational Risks 39 3.4 Quantification Approaches for Legal Risks 39 3.4.1 General Treatment 39 3.4.2 Enforceability of Claims 40 4 External Ratings 40 4.1 Function of External Ratings 41 4.2 Initial Rating 42 4.2.1 Preliminary Stage 42 4 Contents 4.2.2 Quantitative Analysis 42 4.2.3 Qualitative Analysis 45 4.2.4 Rating Determination and Completion Stage 46 4.3 Ongoing Monitoring of Ratings 46 4.4 Data Requirements Specific to Types of Receivables 47 4.5 Conclusions 48 4.5.1 Securitization Transaction Ratings vs. Corporate Ratings 48 4.5.2 Using External Ratings in the Banks Internal Risk Management 49 5 Risk Management 50 5.1 Meeting Basic Prerequisites 51 5.1.1 Basic Prerequisites for the Originator 51 5.1.2 Basic Prerequisites for the Investor 55 5.2 Execution Stage 56 5.2.1 Structuring Stage for the Originator 57 5.2.2 Specific Investment Decisions for Investors 58 5.3 Ongoing Monitoring and Reporting 58 5.3.1 Risk Controlling 59 5.3.2 Reporting 60 5.3.3 Special Issues for the Originator 60 6 Appendix A: Glossary 63 7 Appendix B: Regulatory Discussion 72 × 5 Best Practices in Risk Management for Securitized Products 0 Introduction This guideline deals with best practices in risk management for securitization transactions and concentrates on two primary objectives: First, it is intended to give a fundamental overview of securitization for readers who have had little or no exposure to the subject. Second, this publication is intended to provide more experienced readers with practically relevant information and guidance for the proper design of risk management mechanisms in securitization. In light of these objectives, this guideline should not be seen as a compre- hensive reference work on securitization structuring, nor as a collection of mathematical methods for risk quantification. Instead, the guideline first pres- ents an overview of the risks associated with securitization. On the basis of these risks, we then elaborate on the resulting practical challenges for risk manage- ment for securitized products. The guideline also describes those approaches to meeting such challenges which have proven reliable in the eyes of experi- enced market participants. Unless explicitly indicated otherwise, the ideas pre- sented in this publication apply to originators as well as investors. Chapter 1 covers the fundamentals of securitization. In that chapter, we point out that securitization transactions are not only to be regarded as a source of risk, but that banks can also use them to control and manage credit risk. In these transactions, banks can assume risk by means of a large number of func- tions and instruments. Given the high complexity and innovative power of securitization markets, effective risk management in this field makes high demands with regard to know-how and flexibility. Chapter 2 gives a description of the key risks specifically associated with securitization. The primary conclusion reached in this context is that the risk structure of securitization transactions goes far beyond the credit risk involved in conventional lending business and thus has to be treated separately in risk management. For cost reasons, it may be difficult for a single bank to provide all the expertise necessary to assess all of the complex structural and legal risks involved in securitization transactions. In risk management, these transactions therefore call for stronger emphasis on the coordination and monitoring of all parties involved as well as consultation with external experts. Chapter 3 examines approaches to quantifying the risks involved in securi- tization positions. The prevalent credit portfolio models provide a basis for the quantification of credit risks in securitizations, but this basis is not sufficient to cover the specific quantitative distribution of credit risks among the parties involved in these transactions. Approaches to the integrated quantification of credit risks, structural risks and legal risks are applied in the process of cash flow modeling. However, these approaches require a great deal of effort and have only been able to quantify a small number of structural and legal risks up to now. Therefore, risk management for securitization transactions cannot focus on a single quantitative method alone but should always use multiple quantita- tive and qualitative approaches. × 7 Best Practices in Risk Management for Securitized Products Chapter 4 explains how securitization deals are rated by external rating agencies. For a banks in-house securitization risk management, the conclusion reached here is that external ratings can only be used to replace in-house risk quantification to a limited extent. Due to the considerable effort involved in risk quantification, however, the use of external ratings does have advantages in terms of costs and can therefore be considered as an alternative for individual securitization transactions. Chapter 5 discusses how the securitization-specific risks identified in the preceding chapters can be addressed in risk management. It is only possible to optimize securitization risk management when certain prerequisites are met by the originator and investor prior to each transaction. A majority of securitization-specific risks can be minimized by designing a transparent and comprehensive structuring process. The ongoing monitoring of securitization positions will then require the originator and investors to adapt their usual credit risk management activities only to a minor extent in order to accommo- date securitization-specific risks.
Load more

Recommended publications
  • Analysis of Securitized Asset Liquidity June 2017 an He and Bruce Mizrach1
    Analysis of Securitized Asset Liquidity June 2017 An He and Bruce Mizrach1 1. Introduction This research note extends our prior analysis2 of corporate bond liquidity to the structured products markets. We analyze data from the TRACE3 system, which began collecting secondary market trading activity on structured products in 2011. We explore two general categories of structured products: (1) real estate securities, including mortgage-backed securities in residential housing (MBS) and commercial building (CMBS), collateralized mortgage products (CMO) and to-be-announced forward mortgages (TBA); and (2) asset-backed securities (ABS) in credit cards, autos, student loans and other miscellaneous categories. Consistent with others,4 we find that the new issue market for securitized assets decreased sharply after the financial crisis and has not yet rebounded to pre-crisis levels. Issuance is below 2007 levels in CMBS, CMOs and ABS. MBS issuance had recovered by 2012 but has declined over the last four years. By contrast, 2016 issuance in the corporate bond market was at a record high for the fifth consecutive year, exceeding $1.5 trillion. Consistent with the new issue volume decline, the median age of securities being traded in non-agency CMO are more than ten years old. In student loans, the average security is over seven years old. Over the last four years, secondary market trading volumes in CMOs and TBA are down from 14 to 27%. Overall ABS volumes are down 16%. Student loan and other miscellaneous ABS declines balance increases in automobiles and credit cards. By contrast, daily trading volume in the most active corporate bonds is up nearly 28%.
    [Show full text]
  • Basel III: Post-Crisis Reforms
    Basel III: Post-Crisis Reforms Implementation Timeline Focus: Capital Definitions, Capital Focus: Capital Requirements Buffers and Liquidity Requirements Basel lll 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 1 January 2022 Full implementation of: 1. Revised standardised approach for credit risk; 2. Revised IRB framework; 1 January 3. Revised CVA framework; 1 January 1 January 1 January 1 January 1 January 2018 4. Revised operational risk framework; 2027 5. Revised market risk framework (Fundamental Review of 2023 2024 2025 2026 Full implementation of Leverage Trading Book); and Output 6. Leverage Ratio (revised exposure definition). Output Output Output Output Ratio (Existing exposure floor: Transitional implementation floor: 55% floor: 60% floor: 65% floor: 70% definition) Output floor: 50% 72.5% Capital Ratios 0% - 2.5% 0% - 2.5% Countercyclical 0% - 2.5% 2.5% Buffer 2.5% Conservation 2.5% Buffer 8% 6% Minimum Capital 4.5% Requirement Core Equity Tier 1 (CET 1) Tier 1 (T1) Total Capital (Tier 1 + Tier 2) Standardised Approach for Credit Risk New Categories of Revisions to the Existing Standardised Approach Exposures • Exposures to Banks • Exposure to Covered Bonds Bank exposures will be risk-weighted based on either the External Credit Risk Assessment Approach (ECRA) or Standardised Credit Risk Rated covered bonds will be risk Assessment Approach (SCRA). Banks are to apply ECRA where regulators do allow the use of external ratings for regulatory purposes and weighted based on issue SCRA for regulators that don’t. specific rating while risk weights for unrated covered bonds will • Exposures to Multilateral Development Banks (MDBs) be inferred from the issuer’s For exposures that do not fulfil the eligibility criteria, risk weights are to be determined by either SCRA or ECRA.
    [Show full text]
  • Asset Securitization
    L-Sec Comptroller of the Currency Administrator of National Banks Asset Securitization Comptroller’s Handbook November 1997 L Liquidity and Funds Management Asset Securitization Table of Contents Introduction 1 Background 1 Definition 2 A Brief History 2 Market Evolution 3 Benefits of Securitization 4 Securitization Process 6 Basic Structures of Asset-Backed Securities 6 Parties to the Transaction 7 Structuring the Transaction 12 Segregating the Assets 13 Creating Securitization Vehicles 15 Providing Credit Enhancement 19 Issuing Interests in the Asset Pool 23 The Mechanics of Cash Flow 25 Cash Flow Allocations 25 Risk Management 30 Impact of Securitization on Bank Issuers 30 Process Management 30 Risks and Controls 33 Reputation Risk 34 Strategic Risk 35 Credit Risk 37 Transaction Risk 43 Liquidity Risk 47 Compliance Risk 49 Other Issues 49 Risk-Based Capital 56 Comptroller’s Handbook i Asset Securitization Examination Objectives 61 Examination Procedures 62 Overview 62 Management Oversight 64 Risk Management 68 Management Information Systems 71 Accounting and Risk-Based Capital 73 Functions 77 Originations 77 Servicing 80 Other Roles 83 Overall Conclusions 86 References 89 ii Asset Securitization Introduction Background Asset securitization is helping to shape the future of traditional commercial banking. By using the securities markets to fund portions of the loan portfolio, banks can allocate capital more efficiently, access diverse and cost- effective funding sources, and better manage business risks. But securitization markets offer challenges as well as opportunity. Indeed, the successes of nonbank securitizers are forcing banks to adopt some of their practices. Competition from commercial paper underwriters and captive finance companies has taken a toll on banks’ market share and profitability in the prime credit and consumer loan businesses.
    [Show full text]
  • Personal Loans 101: Understanding Your Credit Risk Loans Have Some Risk for Both the Borrower and the Lender
    PERSONAL LOANS 101: Understanding YoUr credit risk Loans have some risk for both the borrower and the lender. The borrower takes on the responsibilities and terms of paying back the loan. The lender’s risk is the chance of non-payment. Consumers can choose from several types of loans. As a borrower, you need to understand the type of loan you are considering and its possible risk. This brochure provides information to help you make a smart choice before applying for a loan. 2 It is important to review your financial situation to see if you can handle another monthly payment before applying for a loan. Creating a budget will help you apply for the loan that best meets your present and future needs. For an interactive budget, visit www.afsaef.org/budgetplanner or www.afsaef.org/personalloans101. You will need to show the lender that you can repay what you borrow, with interest. After you have made a budget, consider these factors, which maY redUce or add risk to a Loan. 3 abiLitY to repaY the Loan Is the lender evaluating your ability to repay the loan based on facts such as your credit history, current and expected income, current expenses, debt-to- income ratio (your expenses compared to your income) and employment status? This assessment, often called underwriting, helps determine if you can make the monthly payment and raises your chances of getting a loan to fit your needs that you can afford to repay. It depends on you providing complete and correct information to the lender. Testing “your ability to repay” and appropriate “underwriting” reduces your risk when taking out any type of loan.
    [Show full text]
  • Operational Risk Management Guide
    OPERATIONAL RISK MANAGEMENT GUIDE U.S. DEPARTMENT OF AGRICULTURE FOREST SERVICE 2020 Last Updated 02/26/2020 RISK MANAGEMENT COUNCIL IN COOPERATION WITH THE OFFICE OF SAFETY & OCCUPATIONAL HEALTH and THE NATIONAL AVIATION SAFETY COUNCIL Contents Contents ....................................................................................................................................................................................... 2 Executive Summary .................................................................................................................................................................. i Introduction ............................................................................................................................................................................... 1 What is Operational Risk Management? ................................................................................................................... 1 The Terminology of ORM ................................................................................................................................................ 1 Principles of ORM Application ........................................................................................................................................... 6 The Five-Step ORM Process ................................................................................................................................................ 7 Step 1: Identify Hazards ..................................................................................................................................................
    [Show full text]
  • Hedge Performance: Insurer Market Penetration and Basis Risk
    CORE Metadata, citation and similar papers at core.ac.uk Provided by Research Papers in Economics This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: The Financing of Catastrophe Risk Volume Author/Editor: Kenneth A. Froot, editor Volume Publisher: University of Chicago Press Volume ISBN: 0-226-26623-0 Volume URL: http://www.nber.org/books/froo99-1 Publication Date: January 1999 Chapter Title: Index Hedge Performance: Insurer Market Penetration and Basis Risk Chapter Author: John Major Chapter URL: http://www.nber.org/chapters/c7956 Chapter pages in book: (p. 391 - 432) 10 Index Hedge Performance: Insurer Market Penetration and Basis Risk John A. Major Index-based financial instruments bring transparency and efficiency to both sides of risk transfer, to investor and hedger alike. Unfortunately, to the extent that an index is anonymous and commoditized, it cannot correlate perfectly with a specific portfolio. Thus, hedging with index-based financial instruments brings with it basis risk. The result is “significant practical and philosophical barriers” to the financing of propertykasualty catastrophe risks by means of catastrophe derivatives (Foppert 1993). This study explores the basis risk be- tween catastrophe futures and portfolios of insured homeowners’ building risks subject to the hurricane peril.’ A concrete example of the influence of market penetration on basis risk can be seen in figures 10.1-10.3. Figure 10.1 is a map of the Miami, Florida, vicin- John A. Major is senior vice president at Guy Carpenter and Company, Inc. He is an Associate of the Society of Actuaries.
    [Show full text]
  • Asset Pricing with Liquidity Risk∗
    Asset Pricing with Liquidity Risk∗ Viral V. Acharyay and Lasse Heje Pedersenz First Version: July 10, 2000 Current Version: September 24, 2004 Abstract This paper solves explicitly an equilibrium asset pricing model with liq- uidity risk — the risk arising from unpredictable changes in liquidity over time. In our liquidity-adjusted capital asset pricing model, a security's re- quired return depends on its expected liquidity as well as on the covariances of its own return and liquidity with market return and market liquidity. In addition, the model shows how a negative shock to a security's liquidity, if it is persistent, results in low contemporaneous returns and high predicted future returns. The model provides a simple, unified framework for under- standing the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels. ∗We are grateful for conversations with Andrew Ang, Joseph Chen, Sergei Davydenko, Fran- cisco Gomes, Joel Hasbrouck, Andrew Jackson, Tim Johnson, Martin Lettau, Anthony Lynch, Stefan Nagel, Lubos Pastor, Tano Santos, Dimitri Vayanos, Luis Viceira, Jeff Wurgler, and semi- nar participants at London Business School, London School of Economics, New York University, the National Bureau of Economic Research (NBER) Summer Institute 2002, the Five Star Confer- ence 2002, Western Finance Association Meetings 2003, and the Texas Finance Festival 2004. We are especially indebted to Yakov Amihud and to an anonymous referee for help and many valuable suggestions. All errors remain our own. yAcharya is at London Business School and is a Research Affiliate of the Centre for Eco- nomic Policy Research (CEPR).
    [Show full text]
  • Revised Standards for Minimum Capital Requirements for Market Risk by the Basel Committee on Banking Supervision (“The Committee”)
    A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf Basel Committee on Banking Supervision STANDARDS Minimum capital requirements for market risk January 2016 A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2015. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISBN 978-92-9197-399-6 (print) ISBN 978-92-9197-416-0 (online) A revised version of this standard was published in January 2019. https://www.bis.org/bcbs/publ/d457.pdf Minimum capital requirements for Market Risk Contents Preamble ............................................................................................................................................................................................... 5 Minimum capital requirements for market risk ..................................................................................................................... 5 A. The boundary between the trading book and banking book and the scope of application of the minimum capital requirements for market risk ........................................................................................................... 5 1. Scope of application and methods of measuring market risk ...................................................................... 5 2. Definition of the trading book ..................................................................................................................................
    [Show full text]
  • Credit Risk Models
    Lecture notes on risk management, public policy, and the financial system Credit risk models Allan M. Malz Columbia University Credit risk models Outline Overview of credit risk analytics Single-obligor credit risk models © 2020 Allan M. Malz Last updated: February 8, 2021 2/32 Credit risk models Overview of credit risk analytics Overview of credit risk analytics Credit risk metrics and models Intensity models and default time analytics Single-obligor credit risk models 3/32 Credit risk models Overview of credit risk analytics Credit risk metrics and models Key metrics of credit risk Probability of default πt defined over a time horizon t, e.g. one year Exposure at default: amount the lender can lose in default For a loan or bond, par value plus accrued interest For OTC derivatives, also driven by market value Net present value (NPV) 0 ( counterparty risk) S → But exposure at default 0 ≥ Recovery: creditor generally loses fraction of exposure R < 100 percent Loss given default (LGD) equals exposure minus recovery (a fraction 1 − R) Expected loss (EL) equals default probability × LGD or fraction πt × (1 − R) Credit risk management focuses on unexpected loss Credit Value-at-Risk related to a quantile of the credit return distribution Differs from market risk in excluding EL Credit VaR at confidence level of α defined as: 1 − α-quantile of credit loss distribution − EL 4/32 Credit risk models Overview of credit risk analytics Credit risk metrics and models Estimating default probabilities Risk-neutral default probabilities based on market
    [Show full text]
  • Risk Parity an Alternative Approach to Asset Allocation
    FEATURE Risk Parity An Alternative Approach to Asset Allocation Alexander Pekker, PhD, CFA®, ASA, Meghan P. Elwell, JD, AIFA®, and Robert G. Smith III, CIMC®, AIF® ollowing the financial crisis of tors, traditional RP strategies fall short respectively, but a rather high Sharpe 2008, many members of the of required return targets and leveraged ratio, 0.86. In other words, while the investment management com- RP strategies do not provide enough portfolio is unlikely to meet the expected F munity, including Sage,intensified their potential benefits to outweigh their return target of many institutional inves- scrutiny of mean-variance optimization risks. Instead we advocate a liability- tors (say, 7 percent or higher), its effi- (MVO) and modern portfolio theory based approach that incorporates risk ciency, or “bang for the buck” (i.e., return (MPT) as the bedrock of asset alloca- budgeting, a key theme of RP, as well as per unit of risk, in excess of the risk-free tion (Elwell and Pekker 2010). Among tactical asset allocation. rate), is quite strong. various alternative approaches to asset How does this sample RP portfo- What is Risk Parity? allocation, risk parity (RP) has been in the lio compare with a sample MVO port- news lately (e.g., Nauman 2012; Summers As noted above, an RP portfolio is one folio? A sample MVO portfolio with a 2012), especially as some hedge funds, where risk, defined as standard deviation return target of 7 percent is shown in such as AQR, and large plan sponsors, of returns, is distributed evenly among table 2. Unlike the sample RP portfolio, such as the San Diego County Employees all potential asset classes;1 table 1 shows the MVO portfolio is heavily allocated Retirement Association, have advocated a sample (unleveraged) RP portfolio toward equities, and it has much higher its adoption.
    [Show full text]
  • The Market Risk Premium: Expectational Estimates Using Analysts' Forecasts
    The Market Risk Premium: Expectational Estimates Using Analysts' Forecasts Robert S. Harris and Felicia C. Marston Us ing expectatwnal data from f711a11cial a 11 a~r.11s. we e~ t ima t e a market risk premium for US stocks. Using the S&P 500 a.1 a pro1·1•.fin· the market portfolio. the Lll'erage market risk premium i.lfound to be 7. 14% abo1·e yields on /o11g-ter111 US go1·ern 111 e11t honds m·er the period I 982-l 99X. This ri~k premium 1•aries over time; much oft his 1·aria1io11 can he explained by either I he /e1 1el ofi11teres1 mies or readily availahle fonrard-looking proxies for ri.~k . Th e marke1 ri.1k p remium appears to 111 onz inversely with gol'ern111 e11 t interes1 ra/es .rngges1i11g Iha/ required rerurns 011 .~locks are more stable than interest rates themse!Pes. {JEL: GJI. G l 2] Sfhc notion of a market ri sk premium (th e spread choice has some appealing chara cteri sti cs but is between in vestor required returns on safe and average subject to many arb itrary assumptions such as the ri sk assets) has long played a central rol e in finance. 11 releva nt period for tak in g an average. Compound ing is a key factor in asset allocation decisions to determine the difficulty or usi ng historical returns is the we ll the portfolio mi x of debt and equity instruments. noted fa ct that stand ard model s or consum er choice Moreover, the market ri sk premium plays a critica l ro le would predi ct much lower spreads between equity and in th e Capital Asset Pricing Model (CAPM ), the most debt returns than have occurred in US markets- the widely used means of estimating equity hurdle rates by so ca lled equity risk premium puzzle (sec Welch, 2000 practitioners.
    [Show full text]
  • Capital Adequacy Requirements (CAR)
    Guideline Subject: Capital Adequacy Requirements (CAR) Chapter 3 – Credit Risk – Standardized Approach Effective Date: November 2017 / January 20181 The Capital Adequacy Requirements (CAR) for banks (including federal credit unions), bank holding companies, federally regulated trust companies, federally regulated loan companies and cooperative retail associations are set out in nine chapters, each of which has been issued as a separate document. This document, Chapter 3 – Credit Risk – Standardized Approach, should be read in conjunction with the other CAR chapters which include: Chapter 1 Overview Chapter 2 Definition of Capital Chapter 3 Credit Risk – Standardized Approach Chapter 4 Settlement and Counterparty Risk Chapter 5 Credit Risk Mitigation Chapter 6 Credit Risk- Internal Ratings Based Approach Chapter 7 Structured Credit Products Chapter 8 Operational Risk Chapter 9 Market Risk 1 For institutions with a fiscal year ending October 31 or December 31, respectively Banks/BHC/T&L/CRA Credit Risk-Standardized Approach November 2017 Chapter 3 - Page 1 Table of Contents 3.1. Risk Weight Categories ............................................................................................. 4 3.1.1. Claims on sovereigns ............................................................................... 4 3.1.2. Claims on unrated sovereigns ................................................................. 5 3.1.3. Claims on non-central government public sector entities (PSEs) ........... 5 3.1.4. Claims on multilateral development banks (MDBs)
    [Show full text]